Thursday, April 26, 2012

Angela Merkel has said in the past that there is not magic bullet that can save the eurozone, but that it's a process which takes time. The "process" that she refers to is the Grand Plan, which I wrote about before, as outlined by Mario Draghi. It consists of:

"Good austerity" in the form of lower taxes and lower government spending. But the Grand Plan isn't all austerity, all the time. The second component addresses the problem of the competitiveness gap between northern and southern Europe, which means:

Structural reform, which is the European version of the step China took to "smash the iron rice bowl" in order to create labor flexibility for all, not just the young but all of the current employees in their cushy jobs and gold-plated pension plans. Draghi went on to characterize structural reform as the old days of the European social model being all gone.

However, "to deny that fiscal consolidation has some short-term contractionary effects would not be correct," the ECB chief said, conceding later that these effects are now starting to "reverberate."

Structural reforms are essential to restoring competitiveness but will also cause pain in the short term, the ECB president said.

"Structural reforms hit vested interests," he said, adding that they "change profoundly the society." These changes are themselves "a source of pain," he added.

"We are just in the middle of the river that we are crossing. The only answer to this is to persevere and for the ECB to create an environment that is as favourable for this as possible," Draghi said.

He said competitiveness disparities within the Eurozone are a key underlying cause of the crisis and that "the way out is to implement structural reforms that free some of the energies."

At about the same time, Bloomberg reported that Angela Merkel defended Draghi's Grand Plan as not being all-austerity-all-the-time:

Chancellor Angela Merkel backed European Central Bank President Mario Draghi’s call to focus on spurring economic growth, as German officials rejected charges they are fixated on budget austerity to fight the debt crisis.
Europe needs growth “in the way that Mario Draghi, the president of the European Central Bank, said it today, that is in the form of structural reforms,” the chancellor told a conference of her Christian Democratic bloc in Berlin today.

It's a combination of austerity and growth compact:

“We’ve had a fiscal compact,” Draghi said. “What is most present in my mind now is to have a growth compact.”

Given Draghi's current view that the eurozone is "just in the middle of the river we are crossing" and "the only answer to this is to persevere", it appears that the voices against austerity, like French presidential candidate and frontrunner François Hollande, have a fight on their hands. Note how different his version of a "growth plan" differs from the Merkel-Draghi Grand Plan, according to this FT story:

Mr Hollande’s proposed growth plan would comprise four elements: the creation of commonly issued eurobonds “not for the mutualisation of debt but to finance” infrastructure, industrial investment and employment; additional financing of investment by the European Investment Bank, the bloc’s long-term lending arm; the imposition of a financial transaction tax by those EU member states willing to use it to find development projects; and the more efficient use of EU structural or regional development funds.

In the days to come, there will a lot of theatre and inevitable compromises. The theatre will be entertaining, but don't forget that Hollande is committed to Europe and he doesn't want to go down in history as the one who blew up the EU. Expect him to compromise from his election rhetoric, but I would not be surprised if Merkel also compromised on the issue of eurobonds.

All is not lost. Consider the upcoming election in Greece as an example. Despite the pain that the Greeks are feeling, the latest polls show that they don't want to leave the eurozone:

A poll by the MRB company showed that 26.2 percent of respondents intend to vote for a party opposed to the unpopular EU-IMF rescue in the May 6 ballot.

In response to another question, 66 percent said Greece should stay in the eurozone but adopt an alternative recovery plan, while 13.2 percent said the country should drop the euro altogether.

So unless anti-Europe leaders take power, the eurozone is unlikely to fall apart.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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Welcome to my blog Humble Student of the Markets. These are my observations and musings about the markets (mostly equities), hedge funds and investments in general.My experience has been a quantitative equity manager in US, Canada, EAFE and Emerging Markets and commentator on hedge funds and their returns patterns.

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None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. I may hold or control long or short positions in the securities or instruments mentioned.